The FDR Framework is the backbone for a 21st century financial system. Under this framework, governments ensure that every market participant has access to all the useful, relevant information in an appropriate, timely manner. Market participants have an incentive to analyze this data because they are responsible for all gains and losses.

Thursday, January 24, 2013

Failure of financial regulatory system repeated in Dodd-Frank implementation

One of the critical lessons from the current financial crisis is that a financial system dependent upon the combination of complex rules and regulatory oversight is prone to catastrophic failure.

Despite this lesson, the Obama Administration, led by Tim Geithner, decided that we should double down and bet the financial system again on this combination. The result of their bet was the Dodd-Frank Act.

Reuters reports that the very features that make financial systems dependent on this combination prone to catastrophic failure have bogged down implementation of the Dodd-Frank Act.

The U.S. financial regulatory system remains fragmented two and a half years after Congress passed the Dodd-Frank law, and time-consuming coordination among regulators has stalled its biggest reforms, a government watchdog said in a report on Wednesday....

The Dodd-Frank law gave regulators new oversight of the $650 trillion over-the-counter swaps market, called for tough new rules to prevent banks from speculating with their own money, and sought to end "too big to fail" by creating a path for regulators to wind down giant, failing banks.

The complexity and interconnected nature of some required rules has caused regulators to get behind, as has the coordination required for multiple agencies to agree on joint rules.

Also, Dodd-Frank did little to streamline the overlapping organizational chart of financial regulation, which includes numerous federal and state supervisors, the GAO observed.

"The implementation of many of these reforms remains ongoing and the effectiveness of some remains an open question," the GAO said....

Bottom-line: we have agencies with overlapping authority trying to protect their turf while writing rules that are so complex that the rules will be impossible to enforce.

Hmmm...wasn't it the failure of the overlapping agencies to enforce the existing rules that resulted in our current financial crisis?

In particular, all the agencies had the responsibility for ensuring that there was transparency throughout the financial system and that there were no opaque corners. Clearly, given that the financial crisis struck each of the opaque areas of the financial system (think banks and structured finance securities), the agencies didn't enforce transparency.

Financial regulators have pushed out dozens of new rules called for by Dodd-Frank, but they are behind on some of the biggest changes.

A controversial ban on proprietary trading known as the "Volcker rule" was supposed to take effect in July 2012.

The five agencies responsible for the rule -- the Securities and Exchange Commission, Federal Reserve, Commodity Futures Trading Commission, Federal Deposit Insurance Corp and Office of the Comptroller of the Currency -- have not finished writing it....

Regular readers know that your humble blogger "wrote" what should be the Volcker Rule in less than five minutes.

Paragraph one is a restatement of the Volcker Rule: banks shall not take proprietary bets.

Paragraph two is enforcement of the rule: banks shall provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

With this disclosure, market participants, including regulators, can assess each of the bank's exposures to see if it is in compliance with the rule stated in paragraph one and exert discipline on the bank if the exposures are not in compliance.

Please note, the complicated Volcker Rule that the five regulatory agencies are producing was almost 300 pages long when last seen.

There is absolutely no chance that this 300 pages long rule can or will be enforced.

Some rules have been held up while regulators waited for other agencies to craft similar rules. And the GAO said other regulations require coordination among agencies and with international regulators, which can be time-consuming.

"Although regulators have established mechanisms to facilitate coordination and believe coordination efforts have improved the quality of the rulemakings, several regulators indicated that coordination increased the amount of time needed to finalize rulemakings," the report said.

Translation, we are creating millions of pages of rules and regulations that will make the financial system more prone to catastrophic failure.

Elisse Walter, chairman of the Securities and Exchange Commission, said in response to the report that implementing Dodd-Frank has been a "major undertaking" but that the SEC has made considerable progress implementing the law.

Everyone knows that the SEC completely abandoned its responsibility for ensuring that market participants have access to all the useful, relevant information in an appropriate, timely manner so they could independently assess this information and make a fully informed investment decision (the SEC staff abandoned pursuing the SEC's responsibility because it interfered with their becoming high paid partners at law firms after leaving the SEC).

Given that the staff was willing to abandon the SEC's reason for existence, everyone should be nervous when the SEC says it has made considerable progress implementing Dodd-Frank.

About this blog

A blog on all things about Wall Street, global finance and any attempt to regulate it. In short, the future of banking and the global financial system.

This blog will be used to discuss and debate issues not just for specialists, but for anyone who cares about creating good policies in these areas.

At the heart of this blog is the FDR Framework which uses 21st century information technology to combine a philosophy of disclosure with the practice of caveat emptor (buyer beware).

Under the FDR Framework, governments are responsible for ensuring that all market participants have access to all the useful, relevant information in an appropriate, timely manner. Market participants have an incentive to use this data because under caveat emptor they are responsible for all gains and losses on their investments; in short, Trust but Verify.

This blog uses the FDR Framework to explain the cause of the financial crisis and to evaluate financial reforms like the ABS Data Warehouse.